This Could Crush the GBP to USD Exchange Rate
If the U.K. abandons the European Union in the what’s being dubbed the “Brexit,” the British pound (GBP) will depreciate by 20%, warns Goldman Sachs. The bank says investors would resist investing in the U.K. should British citizens reject membership in the European Union (EU) in the 2017 referendum. (Source: “Brexit could slash sterling by 20%, warns Goldman Sachs,” The Guardian, February 4, 2016.)
Goldman Sachs, rumored to have donated a six-figure sum to the “Britain Stronger in Europe” campaign, is not alone. JPMorgan, Morgan Stanley, and Bank of America all agree that the U.K. is better off staying in Europe.
The British economy, in addition, would suffer setbacks from the Brexit. Considering the current account deficit, the pound would drop sharply against the euro and U.S. dollar. (Source: Ibid.)
“A vote for the UK to exit from the EU is an event that would increase uncertainty, weigh on the UK outlook and raise concerns of foreign investors—potentially interrupting the flow of capital to the UK, sending the pound much lower,” said analysts George Cole, Robin Brooks, and Michael Cahill. (Source: Ibid.)
The analysts believe that the Brexit vote could cause the GBP to U.S. dollar exchange rate to lose some 15%–20%. This means the USD/GBP would move in the greenback’s favor, from US$1.45 now to $1.15–$1.20. As for the euro, Brexit would push it from £0.76 to £0.90–£0.95. (Source: Ibid.)
American financial institutions have high stakes in whether the U.K. votes in favor of a Brexit. Their business models depend on a strong presence in the British capital. From London, Wall Street gets easy access to the old continent as a single market. Clearly, if Britain leaves the EU, London would slam this door shut to Wall Street.
American banks such as Goldman Sachs would also have to deal with a bureaucratic mess. These include piles of contracts, derivatives, credit default swaps, loans, and then some. All would need more alterations than if Heavy D’s tuxedo were worn by Mr. Bean.
The Brexit could take years of difficult negotiations, freezing the ECB’s assets and investments in the meantime. It could generate economic and financial uncertainties. As evidence suggests, it is the markets’ greatest enemy right now.
Many financial institutions based in London would move to other European financial capitals. Frankfurt, Dublin, or Milan would gain from London’s loss. The effects on the EU economy would be less severe, but Germany would feel it most. The most affected sector would be automotives, but electronics, steel, chemicals, and food will also suffer. In short, a Brexit is a game that has no winners.
The British financial community is already feeling the pressure to vote “no” in the Brexit referendum. For Wall Street, therefore, a Brexit seems like an especially pointless populist exercise.